Everybody. I'm Yaron Kinar, Deutsche Bank's North America Life Insurance Analyst, and with me today, we have John Hele, MetLife's CFO. Met, as you all know, has gone through some significant changes over the last few years, and to name maybe just a few from the last year, we increased its dividends by 30% a couple of months ago, first increase since 2007, deregistered as a bank, and certainly worth mentioning that also hired a new CFO in September of last year, who's sitting with us today. Prior to joining Met, John had been serving as CFOs of other insurance and financial services companies, Arch and ING Group. Certainly has a much broader perspective that hopefully we can tap this morning. The way this will work today is John will give some opening comments and presentation.
We'll dive into a fireside chat and then open it up for questions in the last few minutes. With that, it's my pleasure to hand it over to you, John.
Thank you. Good morning. Here's our cautionary statement. I'll leave that on for a second and move on. Let me just open this morning with our first quarter in 2013. We really got off to a pretty good start this year. Our operating earnings were up at 12%. We've got all nice green labels here on the right-hand side. Our operating earnings per share were $1.48. We did caution on our first quarter investor call that we do expect this is a bit of a better quarter than we had thought normally in terms of a run rate, and we reiterated our guidance for the year to be toward the high end of our range that we gave for the full year of $535. We would not recommend annualizing the $1.48 at this point.
We did have our premium fees and other revenues growing by 2% in the year, but there's some pension business in the prior year, so it's slightly better than that. What we're very pleased about is our operating expense ratio. We are having an improvement year-on-year, and this is some of the cost-saving initiatives that we've started throughout the firm, and we're only partway. We said we're about a third to about half on a run-rate basis through to our targets for this cost save throughout the firm. The book value per share is up only 2% year-on-year, but we did have some adjustments late last year to our variable annuity book to put it on a better footing, the goodwill on the assumption changes. Our operating return on equity annualized 12.7%, which we're very pleased about.
All in all, we thought it was quite a good start to 2013. The core part of MetLife is to become a world-class company, our core strategy. It is four fundamental pillars. You may have seen this before. Refocus in the U.S. business. That part of the strategy is well underway. We've been changing product lines. The teams in retail have been reorganizing the sales forces. We're doing some relocations to bring the groups together. The U.S. business is really well underway to be refocused to be moving toward less capital-intensive businesses. We are growing our emerging markets on the lower left side. We want to get to 20% of our total earnings from emerging markets. We've announced the acquisition of Provida in Chile, and that'll get us to approximately 17% after we close that. We're moving on that strategy as well.
On the upper right-hand corner, we do have an executive level, an executive group member who's in charge of building our global employee benefits business. We are number 1 in the United States in global employee benefits and life insurance. We're trying to expand that on a worldwide basis. That's moving quite well. Last but not least, is driving toward customer centricity and being much more customer centric, really leveraging our great global brand, Snoopy and the Peanuts characters, and leveraging that around the world. We spoke at our Investor Day at length on variable annuities, which is a key focus of investors when I've been meeting with them since last September. We wanted to leave you with a few key facts. We had many slides on this at our Investor Day. I encourage you to flip through those if you haven't seen that yet.
We showed how the U.S. variable annuity in-force block on our product design has limited risk and made it much more manageable. We have changed our lapse assumption curve based on post-crisis experience. We think that's in a good place. Our annuitization rates so far have been coming in more favorable to our original pricing, but it's very new. We would want several years of experience before we think about changing any of those assumptions. The cash flow analysis, we showed our variable annuities on a cash basis. We can really see what's going on net present value basis. We think the scenarios we showed you suggest a manageable downside risk. If markets improve, it can be quite a good business. Most importantly, we do remain committed to annuities. The products meet a very important consumer need.
This will be growing over time with the demographics in the United States and other countries. We just will create annuities that have a good risk profile to the firm, a very balanced approach. We're innovating in many ways on this front. We're working on some new products this year. A major announcement we made at our Investor Day was to change the structure of our variable annuity business. Today, we reinsure our variable annuity business from several U.S. statutory life companies into one reinsurance company. That's based in the Caymans. The reason we did this was so that we could take all the different risks in these different statutory entities and put them in one single entity to run a derivative program to manage that risk.
Otherwise, we'd have to run derivative programs in four or five different statutory entities that are smaller, and it's much harder to amalgamate and run a good derivative hedging program. For a variety of reasons, we decided to bring that business back onshore and merge three U.S. statutory life companies together to create one larger, non-New York life insurance company. We'll be putting all that VA business back into the U.S. life company. This will help position for Dodd-Frank initial margin derivative collateral requirements that are starting this year, and will be phased in over the next five years. It also proactively addresses regulatory concerns about the use of captive reinsurers. By the end of 2014, when this is all completed, you'll be able to see, as an investor, in our blue books, all the reserves and capital that is back in this entire business.
It's very complex to do these calculations with the U.S. statutory reserve systems for variable annuities, and we're still doing many runs to calculate these out. We do expect that once this is all done, our combined RBC ratio will still be above 400%. At our investor day, we gave a lot of information on our free cash flow, and this is a very important focus for us throughout the firm. We did tell you that cash at our holding companies is anticipated to exceed our initial guidance in 2013. We expect free cash flow ultimately to be 35%-45% of our operating earnings over the 2014-2016 period. We really want to reiterate, cash generation is a high priority for us, and we're working to increase this.
With U.S. GAAP accounting for life insurance companies, it's a very challenging product that comes out, both from us having to produce it and as investors and analysts having to figure it out. We'll make sure to give you the cash that's being generated from the subs and speak about that on an ongoing basis so you can see what's going on on a cash basis. We also gave some guidance at our investor day for a very key question that I've had since I joined last September. What happens if interest rates remain low indefinitely? This calculation was done, what happens if rates stay about 1.7%? When we did this calculation, that's the 10-year treasury. It's come up since then, but only in the last really month. We did do this run. We looked all over the world in everything we do.
We looked at statutory, we looked at goodwill, we looked at U.S. GAAP reserves, we looked at DAC, and our results of all this work was that we don't expect any immediate reserve strength on a statutory basis, particularly in the U.S. We have been slowly increasing reserves on a voluntary basis, about $300 million pre-tax a year for several years. That would be continued in the statutory U.S. entities. The GAAP charges are quite modest when you look at the earnings power and the book value of our firm. We expect no one-time GAAP loss recognition, no goodwill impairment. We would have some GAAP reserves, the present value of which would be slowly done over about 10 years, about $750 million net present value pre-tax.
DAC unlocking, the total amount, mainly from variable annuity business, would be about $2.85 billion in total pre-tax, that's a net present value. But none of these two calculations would be done immediately. We would not wake up tomorrow and say we're going to lower rates worldwide, particularly given the recent experience. We'd wait and see. Let's say quantitative easing is stopped, rates go back down again, they stay low. We'd probably change the assumptions down a bit. A bit, not all the way. We'd think about it. We'd watch it for another few years. You'd crank it down again. That's why we say these changes would happen over a period of time. You wouldn't decide rates are never going up in the United States of America for the next 100 years until you really give it some time to really see what happens.
That's why we say this would be spread out. Given the earnings power of MetLife and the capital base, this is really a very modest risk. As a way of introduction, we think we had strong results in the first quarter, despite some headwinds. Our strategy is making good progress. We are increasing our operating ROE. We're decreasing the risk of our firm, which will lower, hopefully, our ultimate cost of equity. We're very committed to delivering shareholder value. Thank you.
Thank you. Thanks, John Hele. I think that there are two general themes that are on investors' minds these days, interest rates and Washington.
Yes.
I was hoping to touch on both of them. The company certainly did a great job of presenting its sensitivity to a low-rate environment. But as some are getting more constructive about rates and maybe the different type of questions, and one you haven't heard in several years now, what does, let's say, a 4% environment mean for MetLife? What does it mean for ROEs? What does it mean for earnings? How do you see that? Maybe as two kind of side questions, what is too quick a move up to 4% mean for the company? I know this may sound crazy, but let's say by the end of this year or the beginning of next year. What is the level or the steepness of the curve, what kind of impact that would have on the company?
Three questions. The first one is what happens if longer-term rates get up to 4% or some higher level? When we gave our guidance at our investor day and talked about our long-term strategy, we said the goal for MetLife was to be 12%-14% ROE for the firm. The way we got to those numbers was if rates sort of stay low, we are more at the 12%. If rates get back to, say, the 4%-4.5% level, it's more like a 14%. That's really the range and why we gave a range. Those numbers assume that we execute our strategic initiatives that we've laid out, our cost-saving programs, our shift to business, the emerging markets growth. That's how we would get to those sort of numbers.
That was always thought of in our plans in how we think about the ongoing business. You're quite right, until just a few weeks ago, no one has ever asked about what happens if rates go up. It's always been what happens if rates stay down or stay down forever. It's been quite a delightful question to answer recently. That's probably one of the best environments for life insurance companies, a slowly rising investment scenario, because you can reinvest on an ongoing basis, you get high coupons, and you move ahead. In terms of our earnings power, the first quarter, we did have good spreads in the United States. They've held up very well, really, on a historical basis. I wouldn't expect to see spreads really expanding a great deal from where we are.
Our forecast, when we speak about 2013, we've always assumed spread compression. We think that would be mitigated a bit. Slowly over time, it takes, even with rates going up, we have a pretty big portfolio. We're not really active traders, it would take some time to get that along. That's why we give this more in the 2016 guidance range. It will slowly have an impact over time. Your question about a rapid rise. There's economic and there's accounting. On an economic basis, it doesn't have much impact on us from the general account because we're quite well matched. We're duration matched. It's how we run the whole company. We'll have the cash flows, and we don't have to sell assets. The economics, the cash flow would all be there.
In fact, you would next year, if we end this year higher, when we do our Regulation 126 testing at year-end in the statutory ME, those would improve, and we'd have some slow release of statutory earnings. Capital should be released. I don't have those calculations done. We haven't spent a great deal of time calculating things out if rates go up. We've been spending all our time for our investors to look at when rates go down. I look forward to doing those runs for you. It's very manageable. On an accounting basis, we do have this inherent mismatch between our liabilities and our assets. We have a pretty big AOCI today that'll slowly go down. I don't really worry that much about the accounting side of it. The rating agencies and others really look through all that piece. They care, are you matched?
Are you going to have the statutory earnings to drive the cash for the entire company? Your third question was on the steepness of the curve. Our overall duration in the U.S. is 5 to 10. It depends on the product lines. They're quite different between the various product lines. If the 30-year goes way up or down, it really doesn't have that much impact on us. That's really where our curve is, why we use as a reference point often the 10-year treasury is when we communicate or do our planning.
Okay. Maybe as a follow-up to that, how do you think about disintermediation risk? Also what would happen if mortgage holders, that starts extending the duration to a degree and maybe does cause some mismatches or unplanned mismatches?
If you have mortgage-backed securities, people may not prepay as much. The prepayments are down in total anyway, just from the whole economy. People have not been able to sell their home or move. We have a very well-diversified portfolio across a broad range of different asset classes. All that's very manageable in the total of the MetLife balance sheet. Disintermediation, we've actually been able to keep our gross investment income pretty high on a relative basis because many years ago, before I joined, Met made the very smart move of buying long-term derivatives to keep the investment income up. Those derivatives, we're seeing the benefit of today, and they're long-term, so we'd see them for the next few years. I think it actually goes out as far, some of them go as far as 2020.
The concern has been historically, if rates stay low forever, those will wear off, and you'll have spread compression. We really haven't seen spread compression yet. We've been able to pay pretty competitive rates on an ongoing basis. You'd have to get rates up quite a bit in order for people to offer high enough rates for people to really disintermediate. We, again, have a very broad-based product line. Yes, we have fixed annuities, but a lot of our GICs and our funding businesses don't have surrender ability. They're locked into the end of the term. We're well matched on that, so we can offer a competitive rate when it comes on. We also have a lot of business, group business, property and casualty business. Those just reset. We would just get the benefits of the higher float on an ongoing basis.
Because Met is very diversified in all of our business lines, it really helps mitigate all these changes up and down.
Okay. When you look at new funds today, what kind of investments are you looking at?
It's nothing that different from what we've done historically. We really have a broad base Corporate credits and some mortgage-backed securities. We do some commercial mortgages. It's really a broad base of investment. There's nothing that special with changing from what we've historically done. The spreads in the markets are not bad today. Not the highest ever, but really not too bad. It's sort of a cautious, slow growth investment environment. We are seeing slow signs of life here and there within the U.S. economy, which is good. Very slow. There's nothing huge about it. We've always been having a piece of our portfolio in private equity or commercial real estate, and we're keeping that percentage around the same, but we always see continued opportunities there as well.
Okay. Maybe we move on to the next hot topic of the day, Washington. FSOC's announcement on Monday, I don't think it was any major surprise to anybody, including the fact that MetLife was not mentioned there. Yet, do you have any thoughts as to what the next steps may be or when you may actually see your name pop up?
As you may know, but I don't know if everyone is aware, there are three stages to the designation process. There's stage 1, which is a calculation by the FSOC team as to do you meet the requirements under Dodd-Frank. We clearly meet the requirements. One of the requirements is you have $50 billion of assets. We definitely meet those requirements. We do calculations over one group of criteria. If you pass stage 1, you move to stage 2. Stage 2 is a confidential, private affair between government and regulators, and the FSOC would contact our local regulator, say, New York State, and share information. We're not told if that's going on or not. I believe it takes a vote of FSOC to move you from stage 1 to stage 2. Once you pass stage 2, they decide we go to stage 3.
That's when they contact us, and we give them a lot of information. That can take quite a while. There's a lot of data that they request, I hear from my friends at the other firms. When they finally get done all that, they say, "Okay, we are done." They send you a note. We've had all of the information. It goes to the FSOC committee. At the next meeting, they vote, and they decide, the process starts that you might be named, and you can have a hearing. You can decide. There's a process. They go through that. AIG, Pru, and GE Capital are now going through. Because we had a non-bank holding company until just recently, my assumption is they didn't really start the process until we had really de-banked, and we were alone. The clock started ticking.
We, as of today, have not been notified that we're in stage 3. Now, maybe the letter is in the mail, post office, as we sit here, so far, we haven't been named. If we are named, we will comply and send them all the information and start that whole ball rolling.
Okay. Aside from the designation, which seems like it's an empty designation right now, I think the question that's most on investors' minds is what will the set of rules actually look like? It fluctuates depending on the day and the person you talk to. Nonetheless, we have started seeing maybe some conversations in Washington, both from Congress and in the Fed itself, about recognizing that insurance companies do have a different business model than the bank business model. I was just curious to hear your thoughts on the Miller-McCarthy bill that just was presented a couple of weeks ago and maybe some of the conversations or statements that were made by the Fed the last month.
Right. If you're picked a non-bank SIFI, there are two major impacts on the firm. The first is you will be regulated as a group by the Federal Reserve. You'll have a global regulator that regulates you at a holding company level. We had been a bank holding company, and we had the New York Fed for many years acting as the group regulator for MetLife. We're used to the procedures, the process. Our chief risk officer reports directly to the CEO on the things they've been doing in banks, having us do as well. We've run stress tests. We've created an infrastructure to deal with all that. When you are picked a non-bank SIFI, you're regulated by the Fed, but you're subject to enhanced supervision. They ask you to do a lot more. We will have to do more.
I think our firm, at least we've been through it with the New York Fed already. I think we understand what we have to do and how we have to think about doing it. I think MetLife will be in fine shape for meeting that side of the requirement. It's going to be a lot of work. It takes a lot of time and effort. They do ask a lot of things, but I think we're in pretty good shape for that. The second aspect is what will the capital calculation be? Because if you picked a non-bank SIFI, if you picked a bank SIFI, you get a capital add-on. For a bank, it's pretty easy. They have a system, and you get a Core Tier 1 ratio, and you have an add-on to it, anywhere between, I think it's 50 basis points to 2% or something.
Different banks have different capital add-ons to their ratios. The fundamental issue for a global insurance entity, such as Met and the other people who have been named as non-bank SIFIs, is what system do you use? I think initially last year, the Fed in early discussions was thinking to apply Basel III or Basel, and Basel III is adopted, to an insurance company. Total consolidated balance sheet. That would include all of our U.S. life business, our U.S. P&C business, our Japanese business, our companies in Europe, and applying really a system that's been designed and calibrated for banks over the last 20, 30 years. We've done some initial work on it, and we've come to the conclusion it really doesn't work very well at all. Why is that?
Well, there's different calibrations for different charges and different risk weights, but it also doesn't reflect two of the major risks that are in insurance companies that banks have a far less risk on. The first is it doesn't measure liability risk. It's one thing to have liability risk, say, in a life insurance contract, but it's very different to have the life insurance risk, say, in commercial P&C or in auto insurance or things that the liabilities can move around quite a bit. The Basel system doesn't pick that up at all today. It also doesn't measure asset liability management, which is the core essence. What we spend a great deal of time doing as a company in risk is matching our assets and liabilities. That's why to the earlier question, what happens if rates go up?
If you're well matched, it has accounting noise perhaps, but it really doesn't impact your cash flow. That's why the statutory systems are designed to reward well-matched business and have charges, C3 charges, if you are mismatched. The Basel system doesn't pick that up at all directly, and that's going to be quite a challenge for both the companies involved and also the regulators in really using it. Even though we believe that MetLife, we are not systemic. We don't think that the failure of MetLife and the financial system would cause a systemic run in any way, shape, or form. We don't have counterparty risk. We don't have a business, a derivative trading business. We don't write derivatives, so we don't have that interconnectedness that banks have or the financial institutions might have.
Nevertheless, we are working and being prepared if we were to be picked as a non-bank SIFI. We have proposed to the Fed and to others a regulatory system that works on activities. You add up across the different types of businesses you have, the required capital and the actual capital, create a ratio, and move across and come up with a total number. That way, the regulations that apply to U.S. life companies, you would use. U.S. P&C companies, you use those. Japanese life companies, you'd use that system. You could add it up to different activities. If you happen to own a bank, you'd use Basel III. If you had an unregulated entity, the Fed, your regulator, would decide what to use for it. This system actually is in place today in Europe. It's called the European Group Directive.
It's how the group regulators, say, the BaFin regulates Allianz and all the different entities across the board. We propose, and we're working with people to think through that type of system. We're pleased by the support we're seeing in Washington, such as the bill you mentioned and others, and other testimonies and questioning to try to make sure that the capital system that's applied to non-bank SIFIs is appropriate. It's very important for the financial institutions of the United States. It's very important for the consumers in the United States because we are all for making sure there's not a systemic problem in the U.S., but to put additional capital on businesses that are not systemic really does no service to anybody. Actually, it will hurt the consumer long term.
Thank you for a thorough response. Why don't we open it up to one, maybe two questions from the audience? Maybe we have time for that. Any questions? All right.
There's one.
There is one.
While you're waiting to find out whether or not you're going to be designated a non-bank SIFI, how does that impact your decisions around capital return?
You can see, we did announce an increase in the dividend. We've taken our dividend to be at a level that is relative to our peers and we think an appropriate return. We've also continued to execute our core strategy as we laid out. We've made an announcement of the acquisition in Chile. That's a $2 billion acquisition. In those realms, we are continuing business as usual and being appropriate. The one area where we are cautious is in thinking about share buybacks. We just don't know where the ultimate capital requirements might be. For now, until we really understand what those rules are, we're really not assuming share buybacks at this time. We think it's much more prudent to wait and see what the rules are going to be.
If the rules work out to be favorable, we can always initiate a share buyback program at that point in time. I'm sure Deutsche Bank would be very pleased to help us execute all sorts of share buyback programs.
Good. Well, thank you very much for attending. Thank you, John.
Thank you
presenting.